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VMWare’s $1.26 billion acquisition of virtualization start-up Nicira shows the success of cloud computing and the strong interest of large enterprise companies in paying top dollar for such startups, says venture capitalist and Nicira investor Marc Andreessen.

While VMWare provides virtualization of servers and computers, Nicira makes software that provides virtualization of networks. Nicira, founded in 2007, changes networking from a mainframe model of expensive hardware to a software model, Andreessen says. “(Nicira) validates the idea of software-defined networking,” Andreessen says. “It creates a new industry for networking software. There’s all kinds of benefits for customers. It’s much easier to deploy a network. It pulls a lot of the logic from the routers and switches to the software.”

For virtualization giant VMWare, which is majority owned by EMC Corp., the deal opens up a whole new market in networking. “This easily more than doubles VMWare’s market opportunity,” Andreessen said. “This positions them very well for the next twenty years.”

Martin Casado, co-founder and chief technology officer of Nicira, worked on the technology for his Ph.D. at Stanford. “It’s an enormous validation of what the team’s been working on,” Andreessen says. “Martin Casado–this is his life’s work.”

Andreessen and his partner Ben Horowitz invested personally in Nicira as angel investors in early 2009 before forming their venture firm Andreessen Horowitz. Then after creating their firm, they invested out of that fund in late 2009 (and bought out their angel investments to not have any conflict of interest). The firm invested $17 million of the company’s $50 million in total funding raised.

Andreessen called the deal “one of the largest all-cash acquisitions of a private tech company.” The deal includes $1.05 billion in cash and $210 million in assumed unvested equity awards. He wouldn’t say the exact multiple his firm generated on its $17 million, but the firm stands to make a very strong return for its investors. Andreessen Horowitz has already previously said it has returned its first $300 million fund, so this exit will add a substantial addition to that return. Other investors Nicira include New Enterprise Associates and Lightspeed Venture Partners.

Meanwhile, the interest in cloud startups from large enterprise companies is very strong now, there should be more deals, Andreessen says. “It’s really lit up,” the Netscape co-founder says. “Activity is running very high.”

After the dot-com crash, optical networking companies were crushed and enterprise startups hit a wall from 2004 to 2008, Andreessen says. “It was very common to talk to VCs and they’d say enterprise computing is dead. There’s nothing new to do… Historically whenever someone believes something is dead, that’s when something dramatic happens.”

That something was cloud computing. A number of startups jumped into that void and have built new technology that larger incumbents now desperately need. Salesforce.com was a pioneer in cloud-based CRM software, but now cloud computing has moved to every part of the enterprise, including the application and infrastructure layers of companies. “Big incumbents have pressing needs to buy their way into leadership positions and have huge cash stockpiles. So it’s prime time for these kinds of deals.”

Andreessen sees what happened in virtualization of servers ten years ago now moving to networks with Nicira. What’s next? Possibly storage virtualization. While there are many startups, “no big companies have moved on that yet.”

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With everybody else falling asleep at the network switch, VMware and Nicira have cornered the virtual server market and thus became indispensable to cloud-based services. But up to now these two had at least each other to compete with. This has assured both strong development in virtual controllers and servers as well as fair pricing. Now, however, the two are about to become one. With everybody else lagging far behind, they will be able to not only monopolize the virtual server market, but also annihilate the old hardware-based switches from Cisco and company. “So what,” you say. “Survival of the fittest.” Not so fast. With the Cisco hardware obsolescence will come a dependency on virtual controllers and servers. This is not bad in itself since they streamline the setting up and maintenance of networks. But it can be bad if the virtual controllers and servers take hold to the exclusion of everything else. Aside from the inherent monopoly in this, we will also have a dependency on a networking platform — which though efficient, economical, and ingenious — has nonetheless not been around long enough to warrant a complete reliance on it. A go-slow approach, therefore, might be in order and the Justice Department perhaps ought to look at all the ramifications before it gives its blessing to VMware to buy Nicira. Besides, the two companies have already worked out the necessary protocol to coexist in networks — without being the same entity. Staying that way might be better for all of us for the time being.

What a great paring of talents in a crucial space as increasingly more organizations head toward cloud computing. Organizations today need the efficiencies both VMWare and Nicira offer through their complementary virtualization solutions. More companies need to embrace at what virtualization can offer the business whether its an enterprise or SMB.